Candlestick Charting Explained: Timeless Techniques for Trading Stocks and Futures - Softcover

Gregory L. Morris

Softcover

ISBN 10: 007146154X ISBN 13: 9780071461542

Publisher: McGraw Hill, 2006

Synopsis

Master this powerful trading system and identify the best trades

Inside this book you will discover candlestick charting, one of the most popular tools in technical analysis. Candlestick Charting Explained features updated charts and analysis as well as new material on integrating Western charting analysis with Japanese candlestick analysis, grouping candlesticks into families, detecting and avoiding false signals, and more.

About this title

About the Author

Gregory L. Morris is a portfolio manager for PMFM, Inc., managing the PMFM Core Advantage Portfolio Trust mutual fund. One of the world's leading experts on candlestick charting, Morris is a consultant and the former CEO of MurphyMorris.com, which he and a partner founded and later sold to StockCharts.com. He is the author of The Complete Guide to Market Breadth Indicators, along with numerous articles for professional publications, and has spoken to thousands of traders and investors at industry conferences around the world.

From the Back Cover

The classic Japanese candlestick reference, updated with all-new insights and tools to improve your predictive accuracy

Candlestick Charting Explained takes the subjectivity out of Japanese candlestick analysis by providing you with standardized, straightforward coverage of 89 powerful candlestick patterns. Inside you will learn what they indicate about current trader behavior and how you can use each to instantly improve your market knowledge and analytical precision.

In this revised and expanded third edition, candlestick expert Greg Morris updates his influential guidebook with valuable new material and patterns to give you:

• Thorough coverage of candlestick patterns to allow instant analysis of investor attitude and probable market direction
• Methods for integrating candlesticks with traditional Western charting analysis for enhanced signal verification
• Completely new section by Ryan Litchfield dedicated to "Trading with Candlesticks"
• Current insights into trader psychology, and how it impacts interactions between buyers and sellers

Its in-depth exploration of traditional as well as all-new candlestick charts, Candlestick Charting Explained will show you how to make candlestick charting a logical, understandable, and profitable component of your current trading program.

Empower your trading with Japanese candlestick charting

Japanese candlestick charts dramatically improve your understanding of short-term (less than a week) market sentiment, making you a much more informed and focused trader of stocks, futures, and indices. The bestselling Candlestick Charting Explained focuses on the patterns themselves and highlights the key facts you need to know to apply each pattern to your trading. For each of 89 distinctive candle patterns, its standardized format provides you with:

• Commentary--Description of pattern and significance of its name, insights into unique features, and other concise explanation
• Rules of Recognition--Simple rules for quick, accurate identification along with precise, day-by-day descriptions of pattern development
• Scenarios and Psychology Behind the Pattern--Trading scenarios that could have led to the pattern's development, with general discussion of the psychology of each
• day's action
• Pattern Flexibility--Situations that change the pattern's effectiveness with explanations of allowable deviations from the classic pattern
• Pattern Breakdown--Instructions for reducing the pattern to a single candle line and whether or not outside confirmation is suggested or unnecessary
• Related Patterns--Patterns that have similar formations, could be considered variations, or are a part of this pattern
• Example--A graphic example of the pattern to both aid in recognition and eliminate costly confusion in pattern identification

Additional information and insights present different interpretations of candlesticks based on intraday instead of end-of-day events and action, improving signal reliability. The author's unique candle pattern filtering concept, instrumental in answering the "how" question, is updated to utilize today's larger universe of stock data. An all-new chapter provides practical application and perspective traders need to view candles in the context of today's computer-driven marketplace.

For millions of traders, candlesticks have become a key tool in creating and verifying trading signals. Candlestick Charting Explained is the only book you need to start integrating their proven versatility and effectiveness into your technical trading program.

Excerpt. © Reprinted by permission. All rights reserved.

CANDLESTICK CHARTING EXPLAINED

Timeless Techniques for Trading Stocks and FuturesBy Gregory L. Morris Ryan Litchfield

McGraw-Hill

Copyright © 2006 Gregory L. Morris
All right reserved.
ISBN: 978-0-07-146154-2

Contents

Chapter One

Introduction

Japanese candlestick analysis is a valid form of technical analysis and should be treated as such. Promoters of instant wealth will always misdirect and abuse their rights, but in the end, they are not around long enough to cause any substantial damage. One should always look into any new technique with a healthy amount of skepticism. Hopefully, this book will keep that skepticism under control and unnecessary.

TECHNICAL ANALYSIS

When considering technical analysis, one should remember that things are quite often not always what they seem. Many facts that we learn are not actually true; and what seems to be the obvious, sometimes is not. Many people believe water runs out of a bathtub faster as it gets to the end; it doesn't. Some people may drink like a fish, but fish don't drink. George Washington neither cut down a cherry tree, nor threw a silver dollar across the Potomac. Dogs don't sweat through their tongues, Audi automobiles never mysteriously accelerated, and the Battle of Bunker Hill was not fought at Bunker Hill (Breed's Hill).

A good detective will tell you that some of the least reliable information comes from eye witnesses. When people observe an event, it seems their background, education, and other influences color their perception of what occurred. A most important thing that detectives try to do at a crime scene is to prevent the observers from talking to each other, because most would be influenced but what others say they saw.

Another curious human failing becomes a factor when we observe facts. The human mind does not handle large numbers or macro ideas well. That thousands of people die each year from automobile accidents raises scarcely an eyebrow, but one airplane crash, killing only a few people, grabs the nation. We are only modestly concerned that tens of thousands of people are infected with AIDS, but we are touched deeply when presented with an innocent child that has been indirectly infected. If a situation is personalized, we can focus on it. We can become deluded by our emotions, and these emotions can affect our perceptions. When our portfolios are plunging, all of the fears that we can imagine are dragged out: recession, debt, war, budget, bank failures, etc. Something is needed to keep us from falling victim to everyday emotion and delusion; that something is technical analysis.

Almost all methods of technical analysis generate useful information, which, if used for nothing more than uncovering and organizing facts about market behavior, will increase the investor's understanding of the markets. The investor is made painfully aware that technical competence does not ensure competent trading. Speculators who lose money do so not only because of bad analysis, but because of their inability to transform their analysis into sound practice. Bridging the vital gap between analysis and action requires overcoming the threats of fear, greed, and hope. It means controlling impatience and the desire to stray away from a sound method to something new during times of temporary adversity. It means having the discipline to believe what you see and to follow the indications from sound methods, even though they contradict what everyone else is saying or what seems to be the correct course of action.

JAPANESE CANDLESTICK ANALYSIS

As a new and exciting dimension of technical analysis, Japanese candlestick charting and candle pattern analysis will help people who wish to have another tool at their disposal; this tool will help sort and control the constant disruptions and continuous outside influences on sound stock and futures market analysis.

What does candlestick charting offer that typical Western high-low bar charts do not? As far as actual data displayed—nothing. However, when it comes to visual appeal and the ability to see data relationships easier, candlesticks are exceptional. A quick insight to the recent trading psychology is there before you. After a minimal amount of practice and familiarization, candlesticks will become part of your analysis arsenal. You may never return to a standard bar chart.

Japanese candlesticks offer a quick picture into the psychology of short-term trading, studying the effect, not the cause. This places candlesticks squarely in the category of technical analysis. One cannot ignore the fact that prices are influenced by investors' psychologically driven emotions of fear, greed, and hope. The overall psychology of the marketplace cannot be measured by statistics; some form of technical analysis must be used to analyze the changes in these psychological factors. Japanese candlesticks read the changes in the makeup of investors' interpretations of value. This is then reflected in price movement. More than just a method of pattern recognition, candlesticks show the interactions between buyers and sellers. Japanese candlestick charting provides insight into the financial markets that is not readily available with other charting methods. It works well with either stocks or commodities. Related analysis techniques, such as candlestick filtering and CandlePower (candle volume) charting, will add to your analysis and timing capabilities.

This book not only will serve as a complete guide to Japanese candlestick charting and candle pattern analysis, but will also provide conclusive evidence of the usefulness of candlestick patterns as an analysis tool. All methods of analysis and all assumptions will be opened and unobstructed. You will, after reading this book, either begin to use candlesticks to assist in your market analysis and timing or be confident enough in them to further your own research into candlestick analysis.

JAPANESE CANDLESTICKS AND YOU

Once you become accustomed to using candlestick charts, you will find it disconcerting to be limited to a standard bar chart. Without candlesticks, you will feel that you are not seeing the complete picture—that something is missing. Besides providing the quick and easy pattern recognition, candlesticks have great visual appeal. The data relationships almost jump off the page (or computer screen), hardly the case with bar charts.

CANDLESTICK CHARTS VERSUS BAR CHARTS

Throughout this book, the assumed time period will be a single day of trading. It should be understood that a bar or candle line can represent any trading period, not always just a day. However, daily analysis is probably the most common and will thus represent the period of trading for this book. Additionally, the mention of inventors, speculators, and traders will be used throughout with no attempt to classify or define them.

Standard Bar Charts

The data required to produce a standard bar chart consists of the open high, low, and close prices for the time period under study. A bar chart consists of vertical lines representing the high to low range in prices for that day. The high price refers to the highest price that the issue traded during that day. Likewise, the low price refers to the lowest price traded that day.

For years, the only other price element used in bar charting was the close price. The close was represented on the high-low bar as a small tick mark extending from the bar out to the right. Recently, bar charting has incorporated the open price by another small tick on the left side of the high-low bar. This stands true for almost all stock charts and stock data vendors. Most futures and commodity charts have always used the open price because it was more readily available.

Most bar charts are displayed with a volume histogram at the bottom. Charting services also offer a number of popular indicators along with the bar chart. Technical analysis software vendors gave the user a great deal of flexibility in displaying the bar charts. The standard bar chart could be displayed with indicators, volume, open interest, and a large assortment of other technical tools appropriate for that software.

Candlestick Charts

Japanese candlestick charts do not require anything new or different as far as data are concerned. Open, high, low, and close are all that is needed to do candlestick charting. When this was first written, many data vendors did not have open prices on stocks. This problem can be addressed by using the previous day's close for today's open price. This, however, presents a somewhat controversial situation and is thoroughly discussed in Chapter 6.

THE BODY (JITTAI)

The box that makes up the difference between the open and close is called the real body of the candlestick. The height of the body is the range between the day's open price and the day's close price. When this body is black, it means that the closing price was lower than the opening price. When the closing price is higher than the opening, the body is white.

THE SHADOWS (KAGE)

The candlestick line may have small thin lines above and/or below the body. These lines are called shadows and represent the high and low prices reached during the trading day. The upper shadow (uwakage) represents the high price and the lower shadow (shitakage) represents the lower price. Some Japanese traders refer to the upper shadow as the hair and the lower shadow as the tail. It is these shadows that give the appearance of a candle and its wick(s).

When drawing candlestick charts by hand, the Japanese use red instead of white to represent the up days (close higher than open). With the use of a computer, this is not feasible because red would be printed as black on most printers and you could not tell the up days from the down days. This also applies to photocopying.

If you compare Figures 1-4 and 1-5, you can see that the Japanese candlestick chart really does not display anything different from the standard bar chart. However, once you become accustomed to seeing Japanese candlestick charts, you will prefer them because their clarity is superior and allows a quick and accurate interpretation of the data. This matter of interpretation is also what this book is about. Japanese candlestick charting and analysis will continue to grow and gain in popularity. For as long as it is used as intended, only a profit of doom would suggest its demise.

Chapter Two

Candlestick Lines

A day of trading in any stock or futures market is represented in traditional charts by a single line or price bar; Japanese candlestick charting is no different, except that the information is so much more easily interpreted.

There is much information provided in a single candle line. This will help in understanding the psychology behind the many candle patterns described in later chapters. There are a few candle patterns that consist of only a single candlestick and also qualify as reversal patterns. They will be covered thoroughly in the chapter on reversal patterns.

Each type of candle line has a unique name and represents a possible trading scenario for that day. Some candle lines have Japanese names and some have English names. Whenever possible, if the name is in English, the Japanese name will also be given. The Japanese name will be written in a format called Romanji. This is a method of writing Japanese so that it can be pronounced properly by non-Japanese-speaking people. Single candle lines are often referred to as yin and yang lines. The terms yin and yang are Chinese, but have been used by western analysis to account for polar terms, such as in/out, on/off, up/down, and over/under. (the Japanese equivalents are inn and yoh) Yin relates to bearish and yang relates to bullish. There are 9 basic yin and yang lines in candlestick analysis. These can be expanded to 15 different candle lines for a clearer explanation of the various possibilities. It will be shown in later chapters how most candle patterns can be reduced to single candle lines and maintain the same bullish or bearish connotations.

LONG DAYS

Reference to long days is prevalent in most literature dealing with Japanese candlesticks. Long describes the length of the candlestick body, the difference between the open price and the close price, as shown in Figure 2-1. A long day represents a large price movement for the day. In other words, the open price and the close price were considerably different.

How much must the open and close price differ to qualify as a long day? Like most forms of analysis, context must be considered. Long compared to what? It is best to consider only the most recent price action to determine what is long and what is not. Japanese candlestick analysis is based solely upon the short-term price movement, so the determination of long days should be also. Anywhere from the previous 5 to 10 days should be more than adequate to produce the proper results. Other acceptable methods of determining long days may also be used. These will be thoroughly discussed in the chapter on pattern identification and the recognition.

SHORT DAYS

Short days, shown in Figure 2-2, may also be based on the same methodology as long days, with comparable results. There are also numerous days that do not fall into any of these two categories.

MARUBOZU

Marubozu means close-cropped or close-cut in Japanese. Other interpretations refer to it as Bald or Shaven Head. In either case, the meaning reflects the fact that there is no shadow extending from the body at either the open or the close, or at both.

Black Marubozu

A Black Marubozu is a long black body with no shadows on either end (Figure 23). This is considered an extremely weak line. It often becomes part of a bearish continuation or bullish reversal candle pattern, especially if it occurs during a downtrend. This line, being black, shows the weakness of the continuing downtrend. A long black line could be a final sell off; this is why it is often the first day of many bullish reversal patterns. It is also called a Major Yin or Marubozu of Yin.

White Marubozu

A White Marubozu (Figure 2-4) is a long white body with no shadow on either end. This is an extremely strong line when considered on its own merits. Opposite of the Black Marubozu, it often is the first part of a bullish continuation or bearish reversal candle pattern. It is sometimes called a Major Yang or Marubozu of Yang.

Closing Marubozu

A Closing Marubozu has no shadow extending from the close end of the body, whether the body is white or black (Figure 2-5). If the body is white, there is no upper shadow because the close is at the top of the body. Likewise, if the body is black, there is no lower shadow because the close is a the bottom of the body. The Black Closing Marubozu (yasunebike) is considered a weak line and the White Closing Marubozu is a strong line.

Opening Marubozu

The Opening Marubozu has no shadow extending from the open price end of the body (Figure 2-6). If the body is white, there would be no lower shadow, making it a strong bullish line. The Black Opening Marubozu (yoritsuki takane), with no upper shadow, is a weak and therefore bearish line. The Opening Marubozu is not as strong as the Closing Marubozu.

SPINNING TOPS (KOMA)

Spinning Tops are candlestick lines that have small real bodies with upper and lower shadows that are of greater length than the body's length (Figure 2-7). This represents indecision between the bulls and the bears. The color of the body of a spinning top, along with the actual size of the shadows, is not important. The small body relative to the shadows is what makes the spinning top.

DOJI

When the body of a candle line is so small that the open and the closing prices are equal, they are called Doji (simultaneous or concurrent) lines. A Doji occurs when the open and close for that day are the same, or certainly very close to being the same. The lengths of the shadows can vary. The perfect Doji has the same opening and closing price, however, there is some interpretation that must be considered. Requiring that the open and close be exactly equal would put too much of a constraint on the data and there would not be many Doji. If the difference between the open and close prices is within a few ticks (minimum trading increments), it is more than satisfactory.

Determining a Doji day is similar to the method used for identification of a long day; there are no rigid rules, only guidelines. Just like the long day, it depends upon previous prices. If the previous days were mostly Doji, then the Doji day is not important. If the Doji occurs alone, it's a signal that there is indecision and must not be ignored. In almost all cases, a Doji by itself would not be significant enough to forecast a change in the trend of prices, only a warning of impending trend change. A Doji preceeded by a long white day in an uptrend would be meaningful. This particular combination of days is referred to as a bearish Doji Star (Chapter 3). An uptrend that, all of a sudden, ceases to continue, would be caused for concern. A Doji means that there is uncertainty and indecision.

(Continues...)

Excerpted from CANDLESTICK CHARTING EXPLAINEDby Gregory L. Morris Ryan Litchfield Copyright © 2006 by Gregory L. Morris. Excerpted by permission of McGraw-Hill. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: McGraw Hill
• Publication date: 2006
• Language: English
• ISBN 10: 007146154X
• ISBN 13: 9780071461542
• Binding: Paperback
• Edition number: 3
• Number of pages: 560